1. Assume that you are valuing a high-growth firm with high risk (beta) and large reinvestment needs (high reinvestment rate). You assume the firm will be in stable growth after five years, but you leave the risk and reinvestment rate at high-growth levels. Will you undervalue or overvalue this firm?
2. In a valuation example, we can assume that the reinvestment rate would be 25.00% in perpetuity to sustain the 2.5% stable growth rate. What would the terminal value have been if instead we had assumed that the reinvestment rate was 0 while continuing to use a stable growth rate of 2.50%?
a. Higher than $189.7 billion
b. Lower than $189.7
3. Assume that you are reading an equity research report where a buy recommendation for a company is being based on the fact that its PE ratio is lower than the average for the industry. Implicitly, what is the underlying assumption or assumptions being made by this analyst?
The sector itself is, on average, fairly priced.
The earnings of the firms in the group are being measured consistently.
The firms in the group are all of equivalent risk.
The firms in the group are all at the same stage in the growth cycle.
The firms in the group have similar cash flow patterns.
All of the above.
4. Explain If you were an investment banker pricing an IPO, would you primarily use discounted cash flow valuation, relative valuation, or a combination of the two? Relative valuation, because the buyers of the IPO will look at comparables. Discounted cash flow valuation, because it reflects intrinsic value The higher of the two values, because it is my job to get the highest price I can for my client. An average or weighted average of the discounted cash flow and relative valuations.